How to Value Oil and Gas CompaniesGuy Conger
I like to own Oil exploration and production (E&P) companies with a high ratio of oil to natural gas. I would rather own more oil than natural gas. I believe oil will gain more value over time and so will E & P companies with high oil-to-gas ratios.
Oil is more profitable for producers. It is essential to the global economy and is more easily transportable than natural gas. Most oil is used as fuel for cars, trucks, planes and boats around the world.
Natural gas is more of a local commodity because it is difficult and more expensive to transport. The main users are electric utilities that use gas to generate energy for their customers.
Some manufacturers use natural gas as part of their production process, especially in the chemicals industry. But, would more use it if only they had easy, relatively inexpensive access to it?
All signs point to yes, but getting unfettered access to gas starts with having a high number of proved barrels of oil equivalent (BOE).
The challenge, however, is finding an accurate reading … especially when, in many cases, companies simply don’t measure it consistently!
What Do Oil, Gas Companies Really Have in Reserve?
Finding reasonably valued E & P companies with high oil-to-gas ratios gets harder every year. For much of the first decade of the 2000s, many E & P companies replaced their oil reserves with natural gas. This changed with the growth of shale oil “fracking.”
Fracking sites often include abundant natural gas liquids (“NGL”) like ethane, butane, propane and natural gasoline. These liquids fetch higher prices than “dry” natural gas, so E & P companies are shifting production to focus on NGL.
In the U.S., federal regulations define how energy companies report their reserves. The Securities & Exchange Commission defines Proved Reserves as:
The estimated quantities of crude oil, natural gas and natural gas liquids — which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward — from known reservoirs and under existing economic conditions, operating methods, and government regulations prior to the time at which contracts providing the right to operate expire, unless evidence indicates renewal is reasonably certain.
When U.S. companies report their proved reserves, they normally combine all their oil, NGL and natural gas into a combined figure called “barrels of oil equivalent” or BOE.
I often have to dig through their company websites, government filings and company presentations to determine how the BOE breaks down into different categories.
I do this analysis every couple of years. The last analysis I did was in 2012 for 2011 reserves. What makes this analysis challenging is that many companies now don’t separate NGL and oil.
It is a lot of work, but I need to know because I prefer to own companies with large oil reserves.
Valuing reserves is a moving target because these companies are always buying and selling assets and other companies. For instance, Linn Energy (LINE) recently acquired Berry Petroleum (BRY). And Marathon (MRO), Murphy (MUR) and Hess (HES) have all gone through major company restructuring and spin-offs.
Creating a list is where I start to value the companies and find those that are undervalued or reasonably valued.